Like pretty much everyone else on planet Earth, I've been thinking about risk a lot lately. And I suppose I've been thinking pretty much the same thing as everyone else. The following excerpt, from a speech to a bunch of bond dealers, is a bit jargony, but gets the basic point across. Take it away, Felix Salmon:

You and I and Alan Greenspan all thought that credit derivatives were wonderful things because they moved credit risk out of the hands of people who didn’t want it, like banks, and into the hands of people who did want it.

In reality, however, the appetite for risk was never nearly as great as we all thought. $10 billion of loans becomes less than $200 million of credit-risk instruments, and everybody else reassures themselves that they’ve managed to reduce their credit risk to zero, even as the people holding that $200 million in synthetic CDO tranches are reassured by their own single-A or triple-B credit ratings that theyaren’t taking a particularly large amount of risk either.

And of course you know what happens next: some bright spark invents the CDO-squared, which seems to reduce the total amount of risk even further. You take the mezzanine debt, the triple-B stuff, and you do all manner of securitization magic to it, and it turns out that you can turn most of that into triple-A paper, too!

Because it was all triple-A, no one felt much in the way of need to do any analysis of their own: it’s almost impossible to overstate the power of the laziness of the bond investor. You know this from your own work with municipal issuers: the reason for those monoline wraps is not because the issuers have a lot of credit risk, but because the investors are lazy, and don’t want to do their homework, and reckon they can get out of doing their homework so long as there’s a monoline guarantee. Essentially, they’re outsourcing their own job to the monolines. Which might be reasonable for a small retail investor, but is not a good idea if your job is to invest in fixed-income instruments which carry a higher yield than Treasury bonds.

Of course, we all know how reliable those monoline guarantees turned out to be — and that’s a related story. The monolines, just like the ratings agencies, believed far too much in the power of models.

This kind of thing isn't new. The basic idea is that you take, say, a BBB-rated bond (decent quality but not great) and get a monoline to insure it, and suddenly you've got a AAA bond. It's now risk free because even if the bond defaults, the monoline will pay you off. In theory, this is great: somebody who wants less risk in their portfolio is able to buy insurance from someone who wants more risk in return for a greater potential return. Everybody gets what they want — party A gets exactly the investment it wants and party B gets exactly the investment it wants — which makes the bond market more efficient and more liquid.

But although this is true theoretically, in the real world it turns out that risk is usually best measured by whoever is closest to it. In the past, bond buyers were pretty careful about evaluating default risk because they were the ones who'd have to bear it. Then they started selling off that risk, and the monolines, who were eager for business and comforted by the fact that their models had always worked, were just a little less careful. Then credit default swaps were invented and popularized, and risk was sold off even further. And then further. And when you get three or four steps down the line, nobody is seriously analyzing the underlying securities themselves. They're just relying on increasingly on abstract models.

So a system that theoretically makes the market more efficient ends up, for all too human reasons, with no one truly evaluating the risk of all the securities underlying the rocket science. And eventually it comes crashing down.

All of which makes me wonder: is Felix still as bullish about credit default swaps as he has been in the past? Unlike some credit derivatives, there's no question that CDS serves a useful purpose. In theory. But in practice, when their use becomes nearly universal and they start getting packaged two and three vehicles deep, they're deadly even if there's no conscious fraud or abuse going on. They don't so much allocate risk as simply encourage people to ignore it. It's just human nature.

As for me, I'm increasingly wondering if insurance of financial assets (as opposed to physical assets, which are a different story) is a good idea, period. Sure, the upside is that it makes debt markets more efficient, but it's worth asking if we even want these markets to be more efficient in the first place. What has that gotten us aside from gigantic profits for financial firms? And if there's no upside to balance a potentially catastrophic downside, why allow it at all? Maybe, human nature being what it is, there's no substitute for forcing debt buyers to be extremely, personally, conscious of the risk they're assuming when they make an investment. Maybe, in the end, that's the only thing that can keep a credit bubble from overinflating.

I'm not sure. Pushback welcome on this score. But it's certainly worth thinking about the big picture here.

News reports are full of Obama’s determination to advance health care reform, regardless of Republican resistance. But developments taking place behind the public debate tell quite another story, and show the usual suspects--the drug companies and the insurance industry--hard at work to advance their own interests.

Consider, for example, last week’s AARP study showing that Big Pharma has been increasing the prices of the brand name drugs most often prescribed to older Americans at well beyond the rate of inflation. According to an AP account of the report, AARP ”said that prices manufacturers charged for the most widely used brand name drugs rose 8.7 percent in 2008, higher than in years past. The general inflation rate in 2008 was 3.8 percent.”

Perhaps the drug companies are acting out of sheer greed in a deep recession. Perhaps they know that patents are running out, and want to make as much as possible before the plug gets pulled. Or perhaps the drugsters sense impending change and want to rake in the cash before Congress pulls the plug.

Last week, after three Somali pirates holding the American captain of the Maersk Alabama were killed by US Navy SEAL snipers, Senator Dianne Feinstein of California sent a letter to President Obama. In it she noted the danger to US-flagged commercial ships transiting the Gulf of Aden and urged Obama to "place armed security teams on board these vessels to protect the ship and crew from pirate attacks." In a press release Monday, her office quoted Feinstein as saying, "I have listened to a lot of rhetoric and reasons for not doing this and how there must be a political solution to the ongoing crisis within Somalia. But in the meantime, the number of hijackings continues to go up... This is unacceptable."

Rhetoric indeed. I called Feinstein's office several days ago for a clarification: is she suggesting that US-flagged ships carry gun-toting private security contractors? Today came the answer. According to an aide, Feinstein "is still looking at it... still learning about the issue and what our options are." Translation: she has no idea. It's not a response that indicates a great deal of consideration for the pros and cons of arming American merchant ships. More likely, Feinstein was just playing the Washington game, taking advantage of low-hanging political fruit. After all, who doesn't want to protect American crews?

FBI agent Ali Soufan writes in the New York Times about the torture memos:

One of the most striking parts of the memos is the false premises on which they are based. The first, dated August 2002, grants authorization to use harsh interrogation techniques on a high-ranking terrorist, Abu Zubaydah, on the grounds that previous methods hadn’t been working....It is inaccurate, however, to say that Abu Zubaydah had been uncooperative. Along with another F.B.I. agent, and with several C.I.A. officers present, I questioned him from March to June 2002, before the harsh techniques were introduced later in August. Under traditional interrogation methods, he provided us with important actionable intelligence.

....There was no actionable intelligence gained from using enhanced interrogation techniques on Abu Zubaydah that wasn’t, or couldn’t have been, gained from regular tactics. In addition, I saw that using these alternative methods on other terrorists backfired on more than a few occasions — all of which are still classified. The short sightedness behind the use of these techniques ignored the unreliability of the methods, the nature of the threat, the mentality and modus operandi of the terrorists, and due process.

As it happens, I've never made arguments against torture based on whether it works or not. I'm more in the Shep Smith camp: "We are America. We. Do. Not. Fucking. Torture." Still it's worth reminding everyone of exactly what happened with Abu Zubaydah, whose case helped touch off the institutionalization of torture under the Bush administration. Ron Suskind told the story in The One Percent Doctrine, and Barton Gellman summarizes here:

Abu Zubaydah, his captors discovered, turned out to be mentally ill and nothing like the pivotal figure they supposed him to be....Abu Zubaydah also appeared to know nothing about terrorist operations; rather, he was al-Qaeda's go-to guy for minor logistics....And yet somehow, in a speech delivered two weeks later, President Bush portrayed Abu Zubaydah as "one of the top operatives plotting and planning death and destruction on the United States."

....Which brings us back to the unbalanced Abu Zubaydah. "I said he was important," Bush reportedly told Tenet at one of their daily meetings. "You're not going to let me lose face on this, are you?" "No sir, Mr. President," Tenet replied. Bush "was fixated on how to get Zubaydah to tell us the truth," Suskind writes, and he asked one briefer, "Do some of these harsh methods really work?" Interrogators did their best to find out, Suskind reports. They strapped Abu Zubaydah to a water-board, which reproduces the agony of drowning. They threatened him with certain death. They withheld medication. They bombarded him with deafening noise and harsh lights, depriving him of sleep. Under that duress, he began to speak of plots of every variety — against shopping malls, banks, supermarkets, water systems, nuclear plants, apartment buildings, the Brooklyn Bridge, the Statue of Liberty. With each new tale, "thousands of uniformed men and women raced in a panic to each...target." And so, Suskind writes, "the United States would torture a mentally disturbed man and then leap, screaming, at every word he uttered."

When the Jane Harman story first broke, I thought the most interesting question might very well be, Who leaked it? The more I read about it, the more I'm beginning to think I was right. Here's the latest from CQ:

Intelligence officials, angry that former Attorney General Alberto Gonzales had blocked an FBI investigation into Democratic Rep. Jane Harman's interactions with a suspected Israeli agent, tipped off Nancy Pelosi, the House Democratic leader, that Harman had been picked up on a court-ordered National Security Agency wiretap targeting the agent.

In doing so, the officials flouted an order by Gonzales not to inform Pelosi, three former national security officials said.

....A well-placed source said an official from the CIA had gone around Gonzales to inform Pelosi about Harman being picked up on the wiretap...."She knew. We made sure she knew," said one of the former officials, chuckling.

It's not at all clear that Harman did anything wrong here. (Though it's not clear that she didn't either.) What is clear is that the CIA is engaged in some pretty serious message sending against people they don't like. My guess: I don't know how Harman is going to weather all this, but I don't think it's going to turn out well for the CIA. They may have gone a couple of steps too far this time.

Matt goes on to say that this is pretty similar to what happened in the Virginia senate race last year and wonders why the GOP is essentially committing suicide. It's a good question, and despite the general wankery involved it makes it almost irresistable to try to psychoanalyze the current Republican soul. It's all just too weird otherwise. Having gone crackers during the Bush years, and getting convincingly drubbed at the polls for it in 2006 and 2008, the almost unanimous reaction among conservatives has been to double down: focus even more on tax cuts to the exclusion of everything else; focus more on pure obstructionism; focus more on defending torture and insisting that it works great; focus more on gun nuttery even though Obama plainly has no intention of doing anything dramatic about guns; focus more on the absolute craziest pundits. It's as if they're convinced, so deep in their souls, that America couldn't have really turned against them, that they can't even conceive of any strategy other than amping up the lunacy even further.

Cheney and company are working to shift the debate onto the narrow question of whether torture “works,” and as Ben Smith notes, this is probably not an argument Obama wants to have right now.

Nonetheless, Cheney’s high-profile entry into the debate is a net win for Obama and Dems. It makes this whole fight is about Bush’s — or, worse, Cheney’s — legacy, at a time when Republicans want it to be about the current Commander in Chief and whether he has what it takes to keep us safe.

So Cheney wants to talk about whether torture worked. This makes sense for him because it lets him talk about how be believes torture did work, and it doesn't matter if it did or didn't.

Why? Because it lets him act as though he was just looking out for the best interest of the country. This sounds much better than Cheney telling Hannity, "Well, Sean, I had no problem with the CIA torturing prisoners because I'm a vindictive asshole with little regard for the rule of law."

But Cheney must know he can't just say, "We were trying to keep America safe." He can't win that argument, because we have little evidence that waterboarding Abu Zubaida 83 times in a month, for example, protected us from further attack. He has to take the sophism a step further, calling for Obama to release more memos that allegedly prove torture did work.

This brings me back to Sargent's post. Cheney saying something like this is, indeed, a net loss for the Republicans. (How many Republican talking heads are more odious right now than Dick Cheney?) But for Cheney it's a net win. Why? Because it gives his original justification for torture two shoddy legs on which to stand. It doesn't matter if these new memos actually exist. Assuming they're just a conjured slice of Cheney's imagination, Cheney can just keep claiming Obama and Hillary Clinton are keeping them secret because they can't admit he's right.

Obviously, it's a completely cynical way of thinking. It's also a bit fantastical; Cheney might as well have demanded Obama release evidence proving Saddam Hussein was in Al-Qaeda. But why stop there? Cheney's selling himself short. Remember, wishes are free. In his whimsical world, he can wish for anything he wants. And as long as Cheney's wishing for a new reality, he might as well wish that he was right about everything and throw in a wish for a pony, too. That's what I'm wishing he'd do publicly. Then, at least, he'd be providing a sideshow rather than a talking point.